Investment Bank Dinners with Corporate Executives and Hedge Fund Managers: The General Public Not Admitted

“One day in early March [2011], the phone lines of hedge-fund traders around London and New York suddenly lit up. A stock that many of them had placed hefty bets on—Pride International Inc., an energy company in the process of being sold to a rival—was falling. The traders had no idea why. They soon figured it out: J.P. Morgan Chase & Co. had hosted a meeting that day between a handful of hedge-fund traders and executives from a company that was considered a prime candidate to start a bidding war for Pride. One of those executives had indicated they weren't likely to make a bid.”

“The prospect of a bidding war had lifted Pride's shares above where they likely would have traded in the absence of a potential interloper. . . . At the March 8 lunch, though, as the traders munched on scallops and fish, Seadrill vice president and board member Tor Olav Trøim splashed cold water on the idea of a bid. He recalls telling traders that the company's Feb. 24 statement was ‘not normally what you would say if you were interested in bidding yourself. His intended message, according to one person familiar with the matter, is that Seadrill was "very unlikely’ to launch a competing offer for Pride. The information was market-moving, traders say. In the hours after the lunch, some traders wagered that the odds of a bidding war had declined. Seadrill's shares rose more than 1% as it was viewed as less likely to pursue a costly acquisition. Pride's shares fell by about 0.5% in the minutes before markets closed.”

“The moves may seem small, but they were significant for ‘merger arbitrage’ traders, who make short-term bets on deal stocks. In the case of the Ensco-Pride deal, the movements translated into a sudden 64% spike in the deal's ‘spread.’ That arcane measure reflects the difference between a target company's stock price and the per-share value of the acquirer's offer. The spread is closely watched by hedge funds that focus on merger arbitrage, which stand to gain or lose large sums based on the spread's movement. As the shares moved, anxious investors bombarded Seadrill's investor-relations office with phone calls, trying to figure out whether the company had issued new guidance about its appetite for bidding on Pride, according to a person familiar with the matter. Company officials responded that they hadn't released any new information. . . . Trøim says Seadrill executives regularly meet with large and small investors and that it is appropriate to help them understand the company's strategy. ‘We cannot see that we in any way have crossed any lines for giving privileged information,’ he says.”

The full essay is at "Investment Bank Dinners."

Source:

David Enrich and Dana Cimilluca, “Banks Woo Funds with Private Peeks,” The Wall Street Journal, May 16, 2011.

Congressional Ethics: Investing on Insider Info

To what extent should members of Congress be permitted to adjust their investment portfolios in line with general information on the economy gained as part of their legislative work? Whereas insider trading refers to information that is not available to the public on a particular company, the trades at issue as the U.S. headed toward a possible financial crisis pertained to diversified portfolios.

To take one example, John Boehner (R-Ohio), who would become the Speaker of the House after the 2010 Congressional elections, met U.S. Treasury Secretary Henry Paulson for breakfast on January 23, 2008. According to the Washington Post, “Boehner would later report the rearrangement of a portion of his own financial portfolio made on that same day. He sold between $50,000 and $100,000 from a more aggressive mutual fund and moved money into a safer investment. Boehner is one of 34 members of Congress who took steps to recast their financial portfolios  . . . after phone calls or meetings with Paulson; his successor, Timothy F. Geithner; or Federal Reserve Chairman Ben S. Bernanke, according to a Washington Post examination of appointment calendars and congressional disclosure forms. The lawmakers, many of whom held leadership positions and committee chairmanships in the House and Senate, changed portions of their portfolios a total of 166 times within two business days of speaking or meeting with the administration officials.”

The paper points out that the financial moves by the members of Congress were permitted at the time under congressional ethics rules.  Some ethics experts suggested that lawmakers should refrain from taking actions in their financial portfolios when they might know more than the public. In my view, we can assume that lawmakers will know more than the general public on matters relevant to investment decisions; the question is whether those decisions ought to be placed in blind trusts.

Lawmakers are going to know more than the public; merely sitting through hours of hearings will accomplish that. Indeed, part of the rationale for having a representative rather than a direct democracy is that representatives can be in a position to be better informed on the economy because lawmaking is at least in principle their full-time endeavor while they are in office. Essentially, the electorate delegates the popular sovereignty to the representative to focus on the lawmaking role.

Furthermore, human nature being what it is, we cannot but expect the lawmakers to have protected their investments by reducing the level of risk after learning that the U.S. economy could go over the cliff on account of being over-leveraged on subprime mortgages and over-securitized on them plus the related securitized insurance swaps. Adjusting their portfolios based on “insider information” on an upcoming stimulus plan is based on more particular information and thus more problematic even though it is not on a particular company. Regardless of the specificity of the information, however, any private gain from the public service is rightly generally regarded not only as unfair, but also inappropriate and unseemly.

At the very least, for lawmakers to use even the inevitable information they have on the general condition of the economy for private gain detracts from the notion that public service is a duty rather than an opportunity to enrich oneself. In this regard, having citizen lawmakers are preferable to careerists. However, even doing one stint in the U.S. House of Representatives could be financially lucrative, so even with term limits, the question of whether lawmakers should be able to adjust their investment portfolios would be relevant.

Although it is undoubtedly impossible to stop virtually any private benefit from accruing to members of Congress, their management of their own wealth should be separated from their public service where possible. The instrument of a blind trust makes this possible in the case of investments, assuming that direct and indirect communication with the managers of the trusts is preempted effectively. The trusts could even be mandated for several years after the lawmaker vacates public office.

More generally, the opportunistic orientation evinced by several lawmakers in January 2008 suggests that they may have viewed their respective offices less as stemming from a sense of a duty oriented to public service than as being an opportunity for personal gain. Rather than electing citizens who yearn for the office, perhaps we ought to seek out those who have reservations in place of ambition, yet would serve out of a sense of duty if called. In other words, whoever in the two parties gets people to run for the offices ought to be suspicious of people whose sense of duty seems all too comfortable and convenient to come out a sense of obligation. In other words, if it is easy to convince someone to run, then he or she probably is not the best person for public service.

Source:

Kimberly Kindy, “Lawmakers Reworked Financial PortfoliosAfter Talks with Fed, Treasury Officials,” The Washington Post, June 24, 2012. 

Facebook’s IPO: Morgan Stanley’s Conflict of Interest

Morgan Stanley’s underwriting of Facebook’s IPO has been thought by some of the bank’s rivals to be incompetently managed.  According to the New York Times, “(r)ival bankers and big investors have complained that Morgan Stanley botched the I.P.O., setting the price too high and selling too many shares to the public.”[1] Interestingly, the incompetence is positively correlated with unethical policy decisions at the bank. Even as the bankers as underwriters were eager to sell lots of shares, they may have given some of their institutional customers—albeit only the most preferred, as per the bank’s other services—some privileged information. If this charge is true, the conflict of interest at the bank should be closely examined by Congress and any relevant regulators.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

1. Evelyn Rusli and Michael De La Merced, “Facebook I.P.O. Raises Regulatory Concerns,” The New York Times, May 22, 2012.

Efficiency and Ethics: On the Fairness of High-Speed Trading

Two months into 2012, the SEC announced that it had been examining the trading activities of high-frequency trading firms.  According to the Wall Street Journal, the SEC was “examining, among other things, whether high-frequency firms benefit from delays in the dissemination of prices from various corners of the markets. . . . High-speed firms use direct feeds from exchanges that can give them a leg up on slower traders.” High-frequency traders “can access prices a split second faster through their access to direct feeds.” This is accomplished by placing the trading computers in the same data center that houses the exchange’s computer servers. Just over a year later, the Wall Street Journal reported that high-speed traders were using “a hidden facet” of the Chicago Mercantile Exchange’s computer system “to trade on the direction of the futures market before other investors get the same information.” Even getting the confirmation of a high-speed trade just one to ten milliseconds faster can enable a computer to know the direction a commodity is going and trade on it. According to the Wall Street Journal, the “ability to exploit such small time-gaps raises questions about transparency and fairness amid the computer-driven, rapid-fire trading that increasingly grips Wall Street and confounds regulators.” Both the increasing use of high-speed trading and the problem of accountability from a regulatory point of view raise the stakes in determining the ethics of the practice. 

The full essay is in Cases of Unethical Business, available in print and as an ebook at Amazon.com.